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3 reasons why Spanish property prices haven’t fallen (enough)

Something’s wrong with the Spanish property market, writes S. McCoy in a recent article at Cotizalia.com, a financial news website. His analysis points towards a big and desirable fall in house prices – up to 50% by 2011 says McCoy – but there is no sign of this in the “imaginary” official figures, nor in any of the reports produced by the sector. On top of which the government and some banks are already claiming that the market has touched bottom. So what is wrong with the market, and why haven’t prices fallen more? asks McCoy.

Supply and demand

With a glut variously estimated between 800,000 and 2,000,000 unsold homes, and sales of around 200,000 homes a year, it’s going to take 4 years to liquidate the glut, in the best case, points out McCoy for starters. You would expect prices to be tumbling.

House prices to income

A good way to judge the level of property prices is the ratio of house prices over annual disposable income, which ignores mortgage financing issues. This rose to over 7 years at the height of the boom, and has now fallen back to 6.5 years because, although house prices have fallen somewhat, so have incomes. But that is a long way off the historical average of 4, suggesting price falls still have a long way to go.

Rental yields

Another way to judge property prices is the relationship between rental income and prices (rental yields), a type of inverted price earnings ratio. Higher yields mean better value.

Gross rental yields fell to 2% during the boom, below even interest rates. Now that house prices are falling rental yields should be going up, right? Wrong. The property glut is driving down yields, as more owners try to rent out property they can’t sell. Yields tell us that, at present prices, property is a bad investment, so you would expect prices to fall more. But they aren’t.

So why aren’t prices falling more?

McCoy gives 3 reason.

Firstly, because interest rates are so low. That gives borrowers some breathing space, and allows developers to limp along as zombies for longer. Low financing costs mean banks can avoid selling at a loss, by not selling at all.

Secondly, because borrowers in Spain are liable for negative equity, which gives them a big incentive to do everything they can to avoid foreclosure. Borrowers may be in a lot of financial distress, but this keeps some of it from reaching the market.

And finally, because unemployment benefits and the black economy mean that many of the unemployed have managed to keep paying the mortgage, until now at least.

If the economic recession continues for much longer, and if interest rates rise, the distress in the system will reach breaking point, then prices will tumble, warns McCoy. But the sooner the better, he says. “That’s the only way to bring about Schumpeter’s creative destruction, so necessary for this country.”

I should point out, however, that McCoy is talking about the wider market, including all that speculative primary housing built around cities like Madrid and Barcelona. The situation may be even worse for speculative holiday homes in subprime locations, but it’s probably a lot better for prime and A grade property in the best holiday home locations. The market for A+ property in the best locations is international, and not so exposed to the economic situation in Spain. When reading articles like this it is important to realise that segments are the key to understanding the Spanish property market today. It’s not good expecting prices to fall if they are actually going up in the segment that interests you.

About Mark Stücklin

Mark Stücklin is a Barcelona-based Spanish property market analyst, and author of the 'Spanish Property Doctor' column in the Sunday Times (2005 - 2008).

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